Debt Forgiveness Is Inevitable and Will Save the Euro


Greece is going through its worst economic crisis since World War II. The rate of unemployment has jumped to 26 percent, youth unemployment hovers at 50 percent and six years of deep recession is at -7 percent for this year. It’s an incredibly dire situation for Greece and it appears to be getting worse. No matter how many waves of austerity measures — there have been over five — are taken and how many times wages and pensions are put on the chopping block, more is always needed and yet the crisis is still not over.

Greece continues to fall deeper and deeper into debt. Its debt to GDP ratio for this year is around 175 percent and will increase to 183 percent next year. This is the reality of the situation — nothing close to the projections of Greece’s Troika of lenders (the European Commission, the European Central Bank and the International Monetary Fund). In fact, the Troika’s projections have been consistently way off the mark.

All the while, Greece’s situation is taking its toll on the rest of the Eurozone. This is happening for a variety of reasons, but mainly because of the consistent inability of the European Union over the past three years to handle such a small economy. Greece only accounts for 2.7 percent of the Eurozone’s GDP. This goes to show how overly-bureaucratic and grossly inflexible the European Union is. Another shortcoming is that EU politicians are more concerned about pleasing their local and national constituents, than about understanding how financial markets really work. There’s a real danger when problems are not addressed immediately because markets are impersonal and can be cruelly punishing to the Eurozone as a whole (as they have been).

Most international economists agree that we have to forgive Greece’s debt so that the country can concentrate on its real problem: insolvency (due mainly to the country’s structural inefficiencies). Many European economists would also agree, but would never publicly admit this.

The Heavily Indebted Poor Countries (HIPC) treatment, an international debt relief mechanism (launched at the G7 summit in Lyon, France in 1996 following a proposal from the World Bank and the International Monetary Fund), is starting to make more and more sense these days. The objective of this initiative is to reduce the debt burden of highly indebted countries to sustainable levels. Should this be applied to Greece, it would ensure and ought to be conditional to essential restructuring and the development of the country. Greece would be able to recover with due discipline in order to deregulate, simplify and deepen reforms.

Debt forgiveness, however, is a cure that is hard to swallow. The Governments of Europe and the European Central Bank do not want to give up part of their claims. They cower at the mere thought of having to explain all this to their local constituents.

I would also go so far as to suggest a debt restructuring today for some Eurozone countries in trouble. The Eurozone’s debt to GDP ratio is well over 80 percent and not looking sustainable especially because there are slow growth projections and there is enough evidence to suggest it will plunge into a recession next year. This is an explosive picture for the future of the Euro.

By delaying debt forgiveness — most likely until after the German elections next year, Europe could put the Euro currency in danger. There has to be a recapitalization of the banks and this should happen with some Quantitative Easing from the ECB. This is a suggestion that Germany dreads and stops because it panics at the thought of running any inflation since hyperinflation is what they believe gave rise to Nazism. We must, however, allow Europe’s market organizations to operate with market principles and not with fear.

It is important to have a Reality Check and to dismiss the myths and the fear that have been created by linking some controlled single digit inflation (5-6 percent) to an uncontrollable hyperinflation of a million percent. It is not the hyperinflation of the Weimar Republic that caused World War II, but a great deal of stubbornness to look at the economic problems created by the austerity measures that were being imposed on Germany after the First World War.

Debt forgiveness worked for post-WWII Germany — it had its debt fully wiped out and forgiven. Poland in 1990s also remained with a tiny amount of debt after its debt forgiveness.

Thus, we should not let fear and local politics determine our future, especially at a time when we have a soaring rate of unemployment, about 24 percent — close to 50 percent and growing youth unemployment, and millions of Eurozone citizens struggling below the poverty line. These numbers scream out that we should be seriously concerned about growing social unrest rather than inflation and whether it’s a couple of percentage points higher than “normal.”

Debt forgiveness can pave the way for recovery and must be conditional to structural reforms. It can be a chance to remove all the white noise of this impossible-to-reduce debt and get to work on what can spur growth. This will help rebuild trust among the citizens and the State, make Greeks believe there is a way out of the crisis and encourage investors to start putting money back into the country with a lot more confidence. This is needed in order to make up for three years of continuous readjustments for economic predictions and forecasts that were way off the mark.

Predictions overshooting Reality

Prediction #1 Beginning April 2010, Greece implemented a series of deflationary austerity measures for about one year (agreed during the country’s first bailout) and then re-enter the capital markets in 2011.

Reality: This didn’t work out. Even though Greece reduced its deficit level close to six percentage points in one year — an unprecedented feat by any European Union country, clearly this was not sustainable. The country’s deficit has not been able to remain at those low levels due to low levels of productivity and a deepening recession.

Prediction #2 Greece’s debt to GDP ratio will fall to 120 percent by 2020. The IMF had predicted the following short-term ratios: 152 percent in 2011, 158 percent in 2012, 158 percent in 2013, 154 percent in 2014 and 150 percent in 2015.

Reality: The actual ratios are much higher: 175 percent in 2012, 185 percent in 2013 and rising to nearly 200 percent next year and in 2014.

Prediction #3 Greece will begin to climb out of the recession. Prediction of -5 percent in 2012 and growth starting in 2014.

Reality: The recession is nowhere near over yet. Greece will endure a sixth year of recession. In 2012, we count close to -7 percent with GDP collapsing by over 4 percent next year.

Prediction #4 Greece’s economic crisis will be contained so that no other European Union country suffers.

Reality: We are now counting Portugal, Ireland and Cyprus, as well as Spain (seeking aid from the European Financial Stability Mechanism). Italy and France have also taken a hit.

It is clear that the situation has become less and less manageable after the intervention of the so-called Troika of lenders (the European Commission, the European Central Bank and the International Monetary Fund). As Greece continues to struggle with a deepening recession, the pressure to produce a higher level of revenues through various measures like fiscal changes of tax brackets hasn’t worked.

As I have repeatedly stressed, the crisis was misdiagnosed. It was erroneously treated as a liquidity (accounting) crisis and not as a crisis of broken systems as regards the country’s production capacity. The short-term rescue loans have done little in terms of helping Greece restart its engines since the money is mainly being used to service its debt. This is why Greece should be given a break by creditors.

The mistakes: A triple whammy

Whammy #1 A wrong diagnosis of the Greek crisis, which led to overlong meetings, bickering in Brussels and to “solutions” that won’t be able to sustainably solve the problem.

Whammy #2 The IMF is in a dire situation. It has gotten involved in a lending operation with the European Commission and the European Central Bank. Greece’s debt to GDP levels do not seem easily sustainable. It is very plausible that more austerity measure will be needed in case the expected (by December 7) private debt buy back will not be fully effective.

Whammy #3 Local and National politics have been dictating economic solutions. Eurozone governments fear the political costs of their decisions and actions. Their hands are tied and their motives caught up in the prospect of future national or local elections.

Short-term loss, long-term gain

Of course, forgiving Greece’s debt will come at a cost, especially for Germany, which is the largest contributor to the EU bailouts (up to 17 billion Euros). But history has shown that there can be no real recovery unless debt is seriously reduced or completely wiped away, conditional to deep structural reforms that will simplify local bureaucracy and make the economy attractive. Without debt forgiveness, European policymakers will continue to struggle and kick the can down the road.

Yes, Greece has to drastically cut its expenses, but more austerity and public sector spending cuts only serve to plunge the country deeper into recession. Austerity has made it difficult for Greece to meet its fiscal targets, as well as its structural reforms. This is why anything short of debt forgiveness — always conditional to structural reforms — and more bailout funds, is only a way for Europe to buy a little bit of time but at a huge price.

What we need is the political courage, leadership and muscle to put an end to the vicious cycle of bailouts — debt — recession — more bailouts — more debt — more recession. It’s to everyone’s benefit to swallow short-term losses in order to benefit from long-term gain.